If you’re an investor with average knowledge of the markets, chances are you’ve put most of your money into mutual funds.
Makes sense: these funds diversify your investments and put your money into a large pool with others. They’re relatively low risk and allow average folks like you and me to grow their money without learning much about investments. Many of us who have registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs) actually have our money invested in mutual funds.
The biggest criticism of mutual funds is that the fees, most of them hidden, eat away at your investments. And if you invest in mutual funds because you are not overly knowledgeable about the financial industry, these funds can overcharge and you'd never know it.
A number of studies have shown that in Canada we pay some of the highest mutual fund fees in the world. Since few of us investors truly understand these fees, we’ve let the situation continue.
Here’s a breakdown of what the fees are and what they’re used for.
This is the ongoing overhead of running a fund. It’s a ratio that’s calculated by taking the fund’s operating expenses and dividing this number by the average dollar value of the fund’s assets.
The MER is made up of fees paid to the fund manager and the administrative costs of running the fund. That includes accounting, legal, marketing and other fees, even things like postage. Some funds such as international ones have higher MERs because, in theory, the fund manager needs more experience and they’re pricier to run.
In Canada, MERs also include trailer fees, which are the expenses and commission for professional advisors.
According to a 2009 report, Canadians paid MER rates of about 2% to 2.5% for an equity fund, 0.4% to 0.89% for a money market fund and 1.25% and 1.49% for a fixed income fund.
Studies have shown that funds with higher expenses don’t always perform better.
When you buy into mutual funds or sell them, you are also charged fees that go to your financial advisor. Even if you invest via your bank, those sales fees are taken off and given to the bank. Sometimes these are out of pocket, but most of the time they simply come out of your investment and, if you don’t read the fine print, are hidden. Here are some different types of sales or commission fees.
When you buy shares in a fund, you pay an off-the-top fee to your advisor. This limits how much you get to invest when you put your money in — but at least the fee is taken care of and you won’t pay it later when you draw down your investment.
Also known as deferred sales charges. These funds require you to pay a fee if the fund is sold within a certain time frame. So you might pay 5% if you sell within five years, for instance. Often with these funds you are rewarded for holding on longer and after a certain time has passed you don’t pay a fee at all.
These funds have no up-front commission or no fee charged when you sell the fund. In these cases, the advisor involved will be compensated for their work with a 1% trailer fee that’s built into the MER.
This is sobering information, for certain. It’s not a great thought that your hard-earned investment dollars could be gnawed away by fees, some of which are going into the pockets of people doing much better off than yourself.
Still, mutual funds do offer a straightforward way to invest when you have minimal knowledge. Your best approach: read the fine print, grill your advisor about fees and negotiate when there’s room. Then, keep an eye on your money and make sure it’s truly growing, not just getting turned into fees.